Finance Exam 1

Finance

Concerned w/ allocation (investm) of A&L over space and time, under risk and uncertainty; art of $ mgmt; participants aim to price A based on risk, fundamental value, and expected ROR

Corporate financial mgmt

What A to acquire?

How to raise capital?

How to max firm’s value? ***

How to plan for future?

Capital Markets

Financial intermediaries (banks, IB, stockbrokers, MF, etc); gov orgs (Fed Res, SEC)

Investments

Valuation of stocks and bonds; structuring portfolios

Accounting vs finance

Acct: Focus on day-to-day $ flow in and out; rules; recording what is occuring

Finc: Mgmt of A&L; planning for the future

Corporate structure

BOD, CEO, COO, CFO

Board of Directors

Chairman: Responsible for firm’s strategic policies

Comp Comm: 3 outside directors set compensation for senior officers; use stock price perf relative to mkt and industry (benchmarking), EPS, and other firms’ comps

Chief exec officer

Recent separation of COB and CEO; head of co.

Chief ops officer

Actual ops (producing/selling products)

Chief finc officer

Responsible for acct system, raising capital, evaluating effectiveness of ops, evaluating major investm decisions (new plants, etc)

Certifications in finance

Chartered Financial Analyst

Certified Financial Planner

Certified Financial Manager

Certified Treasury Professional

Real Estate Liscences

Chartered Property Casualty Underwriter

Sole proprietorship

Pro: Easy to form, less IT, less gov regs

Con: Personal liab, hard to raise capital, end when they die

Partnership

Pro: Easy to form, less IT

Con: Personal liab, hard to raise capital, end when they die

Corporation

Pro: Unlimited life, lose only investm, transfer ownership, value max firm

Con: Double tax (except S corp), heavy gov regs

S corp

<100 SH, natural persons, nonaliens, one class stock, single tax → all passed to SH; taxed as sole prop/partnership, but LL (deduct 20% of qualified busn income from tax)

3 basic factors

1. A must generate CF (productive)

2. Optimize timing of CF

3. Find optimal tradeoff b/w risk and return (D&E)

Max SH wealth!!

Decisions affecting stock price

What products/series?

How should they be delivered/made?

D&E mix?

% of earnings = div AOT RE and reinvestm
Externally: legality, econ health, tax laws, IR (Fed Res), stock mkt conditions

Will max profits max SH wealth?

No; max profits → using too much debt

Intrinsic value

Professional gives a value w/ all public info and expertise; if stock in equib → IV = mkt price

Business globalization

Improved transportation and communication, less trade barriers, development costs of new products increase from sophistication

Info tech

Need for stronger computer and quantitative skills, less costs and more markets → comp, need for intermediaries decrease by electronic commerce and internet

Corp governance

SH more proactive in replacing managers; SEC made it easier for investm to change w/in firms and requires more info on CEO comp

Agency relationship

1. SH (principal) v managers (agent): How to motivate mgmt to act in SH’s interest; mgerial comp, direct intervention by SH, threat of firing/takeovers

2. SH/mgers v creditors: mgers have duty to protect existing creditors from changes in riskiness in A (existing and future), amt of debt used, future cap structure decisions

Someone who owns an A allows someone to make contracts; Logan is not selling his own home

Major types of mkts

• Physical v financial A

• Spot v future

• Money v capital

• Mortgage v consumer credit

• Primary v secondary

• Private v public

Tech advancements creating competition

Crowd funding, robo-advisors, tech as payment

Changing interest/exchange rates

Capital moves around the world; disrupts local economy

Increased use of derivatives

Derivatives (contract for security); less risks OR speculations → more risk

Direct transfer

Busn give securities (stocks/bonds) to savers; savers give $ to busn; ex) I am buying a busn

Indirect transfer via IB

Busn gives securities to IB, who gives securities to savers; savers give IB $ who give $ to busn; ex) IPO, Tinker and SpaceX

Indirect transfer via financial intermediary

Busn gives its securities to FI who makes a new product and gives its securities to savers; savers give FI $ who gives $ to the busn; ex) Fidelity brokerage electronic fund, savers can buy units to diversify

Financial intermediaries

1. IB

2. Commercial banks (Glass-Stegall)

3. Financial service corps (Citigroup)

4. Credit unions

5. Pension funds

6. Life insurance

7. Mutual funds

8. Exchange traded funds

9. Hedge funds (high min, less regs)

10. PE

Create new products; help investm diversify while gaining benefits of econ of scale; combination of products (life insurance & savings together)

NYSE and American stock exchange

Tangible physical entity; integrated in 2009; ASE = curb exchange

Dealer mkts

Few dealers holding inventories of securities and make a mkt; thousands of brokers bring dealers together with investors; brokers and dealers members of Nat Association of Sec Dealers who license and oversee dealers; dealer’s profit = bid-ask spread

Competition b/w NYSE and NASDAQ

NYSE: more $ volume

NASDAQ: more share volume (has Apple, Microsoft, Alphabet (Google), FB, Intel)

Dow-Jones industrial average

Stock mkt index tracking perf of 30 public blue-chip companies; equal weight

S&P 500

500 large strong firms in America; market weighted like NASDAQ composite index (high tech)

Dutch auction

Public auction where stock price set at highest price bid that would manage to sell ALL shares from IPO; all bigs >= price executed; Fed gov uses for Treasury bills, notes, bonds

Efficient mkts hypothesis

1. Stocks always in equib

2. Impossible for investor to consistently beat the market

Efficient mk when required return (k) = expected return

Stock price changes

Up → go buy → increase D → increase P

Down → investors say it’s not worth that much → sell → lower P

Common equity

CS, APIC, RE

Op income

EBIT

Common div

d = 0.3; div payout ratio

Addition to RE

r = 0.7; retention ratio

Preparing SOCF

Use change in gross fixed A, not net fixed A (add dep); transfer all sources/uses to SOCF; use NI (not change in RE) and pmt of div

NCF

EBT (1 - T) + D = NI + D; assume all noncash items (not D) = 0; finc emphasizes because it’s the cash in co’s hands to work with

Op CF

EBIT (1 - T) + D

Int exp not subtracted because CF discounted back to t time = 0; finc emphasizes because it’s the cash in co’s hands to work with

FCF

CF available for distribution to all investors (SH, DH) after co. makes all investm in fixed A, new products, and WC necessary to ongoing ops

(EBIT) * (1 - T) + D - (change net FA + D) - change CA + change (AP + accr)

Econ value added

Focuses on firm’s mgerial effectiveness in a specific year; measure of addition to SH value, for divisions or entire co.; pos → ROE > cost of equity; correlation w/ stock price

= AT op profit - AT cost of capital = (EBIT) * (1 - T) - (total capital - (AP + accr)) * (WACC)

Weighted av cost of capital

Assumed 12.5%

Int income

Taxed as ordinary income for corps

Div income

50% (AOT 70%) div exclusion if ownership<20%

65% (AOT 80%) div exclusion if 20%<ownership<80%

100% div exclusion if ownership>80%

Depreciation

100% expensing of a certain A (TC&J)

Int exp

Tax deductible up to 30% EBITDA; affects choice of D/E

Div paid

Not tax deductible; paid w/ $A - T; 2017: $1/1 - T; 2018: $1/1 - 0.21

Reparation tax holiday

15.5% tax if before April 17, 2018

Corporate capital gains

Taxed as ordinary income (no caps); pref tax treatment before 1987

Consolidated corp tax returns

Can consolidate tax returns if a corp owns >80% of co.

2018 rule

Can not carry back losses and may only offset 80% of a future year’s EBT from being taxed (carry forward indefinitely)